When Privatization Fails: College Loans

Last week, Joe Nocera had an excellent piece in the NY Times about how college loans became so exorbitant. Nocera first relates his own college loan experience–in 1974:

…I was constantly falling behind on my payments. The bank that administered my federally guaranteed loans would send a stern notice whenever I got too far behind, which would prompt me to cobble together a few payments by skipping some other bill. Then I would start falling behind again.
Though I found the situation onerous at the time, what strikes me now is how benign it actually was. My bank probably didn’t make a dime on me. It never raised my interest rate as punishment, nor did I ever have to pay any late fees. My chronic tardiness didn’t even affect my credit rating. And had I defaulted, I would not have had my wages garnished, or been stuck with the debt if I had filed for bankruptcy. All of which can happen today.

He then asks a very important question:

How did this critically important social program become so unmoored from its original intent, which was to help poor and middle-class students pay for college? To put it another way, why did student loans become more about shareholders than about students?
GEORGE MILLER, a Democratic Congressman from California, has been obsessing about student loans for a long time. “If you were going to start this program all over again,” he says “you would go back to the concept that this is a service, and an investment, provided by the federal government. And you would probably go back to a direct loan program, funded with some sort of revolving fund. That is how the G.I. bill worked. But that is now viewed as foreign and wrongheaded. Now we have this idea that there has to be a business model.”

Granted, some university Boards of Directors would make you think that universities are businesses, but they are non-profit organizations that are supposed to serve the public welfare by educating the public. At its core, the loan problem stems from privatization (italics mine):

The critical markers in the evolution of the student loan begin, really, with the decision to offer federally guaranteed loans through banks and other financial institutions. It didn’t have to be done that way. Congress could have decided that only the government could lend taxpayer dollars. But without a middleman, the loans would be listed as outstanding on the government’s books, thus increasing the federal deficit. It was far more politically attractive to use banks to make the loans, and then guarantee them with the taxpayers’ money.
Even with the guarantee, banks were not terribly excited about administering a loan program for college students with uncertain job prospects. So the government tried to make lending even more attractive. It subsidized the interest rates. In the case of a default, it guaranteed that banks would get back not just the principal but the interest. It took all the risk out of lending.
And to get more loans into the hands of students, in 1972 the government established a quasi-government entity, the Student Loan Marketing Association, now known as Sallie Mae. Sallie’s role was to buy up student loans from banks, freeing capital for yet more loans. It could also market and service loans, but it could not originate them. Although always a corporation — much the way Fannie Mae and Freddie Mac have both government status and corporate status — “it didn’t go all out in search of the next buck,” Mr. Nassarian says.
In the 1990s, two important events took place. First, Congress finally decided to lend directly to students. The Direct Loan Program was an immediate hit; within a few years, it had 40 percent of the market. But this was not the kind of G.I. bill, revolving-fund loan that Representative Miller envisions; its intent was to minimize the cost to the taxpayer, not to the student. So it had many of the late fees and higher interest penalties that private lenders were allowed to impose, and the interest rate was the same, 6.8 percent. Shortly after the program passed, the Republicans won both houses of Congress, and began fighting a rear-guard action against it.

Second, Sallie Mae broke away from the federal government. Its chief executive was an aggressive, profit-oriented man named Albert L. Lord, who feared that the Direct Loan Program would hurt Sallie. Privatization would enable him to fight back.
Once it had the ability to originate loans, Sallie devised marketing plans, sought ways to undercut the government lending program and began convincing college financial aid officers to give it special preference. It wasn’t too long before private lenders won back some of the market share they had lost to the Direct Loan Program; they now control about 75 percent of the market.

Nocera concludes:

But let’s also keep in mind that student loans went from being a service to a business because that’s the way the larger society has evolved over the past few decades. And until society changes, we can hardly expect the student loan business to change.
It’s a sobering lesson in the limits of capitalism. As a culture, we praise the ability of the market to create the proper incentives and do more good than not. And mostly that’s true. But there are some things that are too important to entrust to the profit motive. Shouldn’t paying for a college education be one of them?

This is no way to run an empire.

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6 Responses to When Privatization Fails: College Loans

  1. Drat says:

    Perhaps we should apply a business model to something novel — letting rich people live. Our goal would be to maximize profits, taking from them everything they have. When they have nothing left and are destitute, homeless, and starving, then they are by definition poor and are thereby relieved of their duty to enrich the rest of us.
    See? Thinking neocon is easier than it looks.

  2. Jim says:

    Are you kidding me? Did Sallie Mae take away market share by force? Put a gun to the heads of kids and parents? I think it provides substantial evidence that private entities can adapt to the interests of consumers much more quickly than the government can.
    Government subsidies of college education has created a market where attaining a college degree is not a differentiator, and plenty of college graduates are doing jobs that used to be done by those that never went to college–plus they have college loans on top of it! Government is arrogant, wasteful and inefficient, and it’s sad that so many people walk around with a feeling of entitlement.
    What is funny is posts like Drat’s. He thinks he’s being facetious, but it is already the liberal business model! Democratic Presidential candidates are already talking about things like taking back the capital gains tax reductions in order to pay for socialized medicine and a whole host of programs designed to enrich everyone else.
    I don’t have any more love for Republicans, who are hiding the true cost of the war. The next President is almost certainly going to be a single-term President, falling to the same problem as Bush Sr.–> Reagan’s policies set up a situation where Bush had to raise taxes, and those that elected him turned on him. The next President, Democrat or Republican, is going to have to start paying for this ridiculous war . . . and maybe we should add new taxes for socialized medicine, free education and everything else above that!

  3. iRobot says:

    Jim, you are wrong in thinking people happily took on the loans because it was their choice. It was the increasing cost of college and the decreasing amount of grant aid. How much is the Pell Grant now? Its practically worthless. Without loans there is no way of going to college. Try to get a good job without a college degree. Good luck! Thats thanks to all the “smart” CEOs who off-shored and downsized our economy into ruin.

  4. Zachary Tong says:

    Agreed. I would not be taking loans right now if I didn’t have to. As it stands, my college (Rensselaer Polytechnic Institute), seems to believe in “prestige pricing” and has been aggressivlely raising tuition every year. For the last 15 years, RPI has been increasing tuition by 5.5%, far above the average inflation increase of 2.5-3% during those same years.
    My college is not the only one doing this. Many are hiking prices and treating it as a profitable organization. Our president has her own chauffeur and body guard. Ridiculous. Colleges are just as to blame as greedy student loan organizations.

  5. Jim says:

    First, I didn’t say people happily took on loans, I said that people, given the alternatives available, chose Sallie Mae because they offered the best deal. If people didn’t like Sallie Mae, there are alternatives.
    Second (more to Zachary), this was never an issue of whether you have to take loans out or not, unless you’re proposing completely government-provided college education (because the government does such a great job at so many things . . . ). You might ask yourself whether government subsidized college education hasn’t contributed to the situation that requires you to take as much out in loans.
    Good dialogue.

  6. Lindsey Gaidousek says:

    ” its intent was to minimize the cost to the taxpayer, not to the student”
    So there is a difference between a taxpayer and a student? I’m a student and a taxpayer. Most students are!

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